Investor interest over the next five years will gradually shift back towards active strategies.
That’s one of three predictions Charles Brandes, founder and chairman of Brandes Investment Partners in San Diego, made at the CFA Society Toronto’s Annual Forecast Dinner.
A lot of money has moved into passive vehicles in recent years. For instance, in 2002, 11% of total net assets invested in emerging markets were passive, while 89% were active. In 2013, there was an even split.
This shift, he warns, will catch up with markets. He quotes Andrew Haldane, the Bank of England’s executive director of financial stability: “The move into passive and tracking strategies increases the potential for investor herding and correlated market movements. Both potentially have implications for financial markets dynamics and systemic risk.”
Investors will recognize these and other problems with passive strategies, says Brandes, and that will rekindle interest in active funds.
His second prediction is that value investors will need to look outside North America for bargains.
Equity markets in Canada and the U.S. have been on a tear, so investors won’t find many cheap, fundamentally sound companies on our side of the pond. Over the next three years, the best deals will be in Europe and emerging markets, Brandes says.
Emerging market valuations are especially attractive in both absolute and relative terms. Price-to-book ratios, notes Brandes, are about 1.3x to 1.4x, which historically are very low. But “not all emerging market countries and companies are created equal,” so finding the best deals will require a skilled stock picker’s best chops.
His third prediction: Everyone expects equities to outperform bonds, but over the next 30 years we’ll see equities beat bonds by the widest margin on record.
“It’s not all about to blow,” Christian Stracke, global head of credit research at PIMCO in Newport Beach, California, reassured the audience.
He notes the “permabears” like Nouriel Roubini may be “cooler,” but they’re probably wrong. Bears typically have three main worries:
- Federal Reserve hiking rates too quickly
- China’s economy slowing too much
- Geopolitical risks threatening the market
Stracke says concerns about the Fed are misplaced: Yellen will almost certainly allow rates to stay as low as necessary for as long as necessary.
China has certainly lost momentum, and “there’s more downside to come,” says Stracke. But is it a “core threat” to financial markets? No, mainly because the U.S. economy is susceptible to a Chinese slowdown “only at the margin.”
Geopolitical turmoil, including the situations in Iraq and Ukraine, are clearly human tragedies, but their effect on markets has also proven marginal, Stracke argues.
He also points to the fact that regulators have made it extremely difficult for banks and other financial institutions to take the kind of highly levered risks that proved so disastrous in 2008. Thanks in particular to Basel committee rules, “you don’t have the turbocharger of financial leverage to really generate the next big [crisis].”
Not yet, anyway.
“It may happen years down the road,” Stracke says. There are plenty of extremely intelligent players in the market and some of them, he warns, will probably use their knowledge for ill: they may figure out how to work around the new rules and “lever this thing up” again.
We may not see another meltdown any time soon, but we also shouldn’t expect advanced economies to take off.
“Growth is going to be slower over the next five to 10 years than it was for most of the last 20 or 30,” says Russ Koesterich, chief investment strategist at Blackrock in San Francisco. There are three main reasons for this:
On demographics, Koesterich notes the U.S. workforce used to grow at about 1.5% a year, often as high as 2%. “Last year growth was zero. Maybe it was a little better this year…but it’s not going back to 1%.”
The situation’s worse in Europe and Japan, he adds. “Slower workforce growth means, all else equal, unless everyone else gets more productive, [economic] growth is going to be slower.”
Regarding debt, Koesterich says it’s a “media fallacy” that “there’s been this wonderful deleveraging.” He grants there’s some truth to the idea in that U.S. financial companies, for instance, have lowered their debt. “But the dirty little secret is that if you think about most of the developed world, you still have a debt problem.” Canada’s racked with consumer debt; in the U.S., “where this deleveraging is supposedly furthest along, overall non-financial debt has actually risen.”
Koesterich adds Japan, as well as Italy and other European countries, still have serious debt problems.
The third issue – wage growth – is probably the most intractable, he says. “The slowdown in wage growth predated the financial crisis by anywhere from two to four decades.”
Inflation-adjusted wages for American working-age men peaked in 1974, Koesterich notes. “Think about that: it’s been four decades since the average working-age man in the U.S. got a raise after inflation.”
Bottom line is that in most developed countries “we’re stuck with low wage growth, and over the long term, consumption can only increase as fast as wages increase.”